Forex seasonal patterns: Useful or not?

At certain times – especially around the beginning and end of the calendar year – you see and hear reporting on forex seasonal patterns. Here’s an example from DailyFX that came up when I did a search on Google. The analyst who wrote the article went through the major pairs. He showed both the monthly patterns through the year, and the prior 20 years of results for the month of May. The fact that this stuff is out there suggests at least some folks think it’s useful, but is it really?

Yes and no.

Any edge you can get

For sure, you absolutely want to take advantage of any edge you can give yourself in the markets. The line between being a profitable or unprofitable trader is often quite slim. Anything that helps shift the odds more in your favor is a good thing. If used properly, forex seasonal patterns can help do that. The key there, though, is understanding proper usage.

Avoid mere randomness

A major consideration when looking at forex calendar patterns is understanding what is statistically sound and what isn’t. As I talk about in Forex seasonality: Beware this pitfall, there are a lot of patterns out there that aren’t actually significant in a statistical sense. That means we cannot call them anything but random with a high degree of confidence. Oftentimes, the studies provided to us are simply too small to provide significant results.

This sort of thing happens a lot in the markets. Trader latch on to patterns they seen repeated a few times and take them as a given. They fail to account for the fact that seemingly meaningful patterns can occur completely randomly. For that reason you want to look for more than someone just saying, “Hey, look. The USD has been up 7 of the last 10 years this month.” Here’s a perfect example. At least some analysts admit to the potential shortcomings of limited data.

This is why in my analysis I’ve included tests for statistical significance.

Patterns are not guarantees

My research into forex seasonal patterns has turned up pairs that have moved a given direction more than 70% of the time. While that sounds like a really strong pattern, it’s not a guarantee things will go that way this year. Anything is possible in any given year.

And flipping things around, just because the pattern didn’t work out last time doesn’t mean it has to work out this year. Last year doesn’t alter the odds for this year. If the pattern is up 70% of the time, then you have to expect the chances a rise this year to be 70%. They are most definitely not 100%!

Thinking that past outcomes in a random series influence future ones is called the Gambler’s Fallacy. An example of this is a situation where a fair coin flip produces 5 straight heads. Someone suffering from Gambler’s Fallacy would take that to suggest the odds of the next flip coming up tails is higher than the 50/50 they actually are.

Consider the active fundamentals and/or market psychology

When considering the use of forex seasonal patterns in your trading you should consider the current fundamental and psychological situation of the market. The patterns are necessarily a reflection of something fundamental at work at a very foundational level. They are driven by things like trade and capital flows. In any given year, though, something bigger and more immediate can influence exchange rates. It might be geopolitics or central bank policy, as two possibilities.

Here’s one such scenario.

It’s well reported that the USD tends to be weak in December on a seasonal basis. Imagine there’s tensions in a global hot spot that drives a flight to safety. In that case the USD is likely to buck the seasonal pattern and rise rather than fall.

Flipping things around, what if the Federal Reserve started to look dovish on interest rates. That’s something we’d expect to weaken the USD. In that case the predominant December pattern of dollar weakness could be exacerbated, creating an even better short opportunity.

The point is, you shouldn’t just try to use forex seasonal patterns blindly, without understanding the current market context.

Forex seasonal patterns best practices

Assuming you have a pattern that is statistically significant, as outlined above, and there are no contrary current fundamental market drivers, the way I personally favor using seasonal information is to bias my trading. There’s a couple of ways you can do that.

First, let’s think about direction. The pattern gives you a directional bias. You could use that to filter your trades. For example, let’s consider a 4-week pattern. That’s either a monthly calendar one, or the more fine tuned 4-week pattern presented in Opportunities in Forex Calendar Trading Patterns. If you are a swing trader who holds positions for days to weeks you might only take long trades.

The other way you could make use of the seasonal patterns is in terms of risk. If the current pattern favors a move lower you could perhaps take a bit more risk on shorts and/or take less risk on long positions. I wouldn’t suggest pushing things too far, though. As noted above, just because the market is biased it doesn’t mean it will go that way this year. You don’t want to get caught taking too big a loss if the market does happen to go against the pattern. The markets are littered with traders who got blown up because they thought they had a sure thing!

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About the Author

John Forman is a former Senior Forex Analyst with Thomson Reuters and holds a PhD based on research related to the performance of retail forex traders. He is a 30+ year trading and market analysis veteran and the author of The Essentials of Trading (Wiley, 2006) and Trading FAQs (Trade2Win, 2013). He has been doing and publishing research into forex seasonal trading patterns more more than a decade.